Q. Consider the following actions which the Government can take:
- Devaluing the domestic currency.
- Reduction in the export subsidy.
- Adopting suitable policies which attract greater FDI and more funds from FIIs.
Which of the above action/actions can help in reducing the current account deficit? (UPSC Prelims 2011)
Answer:
1 and 3
Notes: The correct answer is
1 and 3 only.To understand why, we need to look at how a
Current Account Deficit (CAD) occurs. A CAD happens when a country's total value of imported goods and services is greater than the total value of its exports. To reduce this deficit, the government must either increase the money coming in (exports/investments) or decrease the money going out (imports).
- 1. Devaluing the domestic currency (Correct): When a country devalues its currency (makes it "cheaper" compared to others), its goods become cheaper for foreign buyers. This usually leads to an increase in exports. At the same time, foreign goods become more expensive for people at home, which reduces imports. This double effect helps shrink the trade gap.
- 2. Reduction in the export subsidy (Incorrect): An export subsidy is financial support given by the government to local businesses to help them sell products abroad at lower prices. If the government reduces this subsidy, local products become more expensive and less competitive in the global market. This would likely decrease exports, which would actually increase the Current Account Deficit.
- 3. Adopting suitable policies to attract FDI and FIIs (Correct): While Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) technically sit in the Capital Account, they are the primary tools used to "finance" or offset a Current Account Deficit. In a broader policy sense, an influx of foreign funds strengthens the overall Balance of Payments and can help stabilize the currency, making it easier to manage the deficit.